Critical Path: On the Comeback Trail

When William E. McGlashan Jr. was hired to help turn around Internet messaging company Critical Path (CPTH) in April, 2001, the company's chances of survival looked slim at best. Shunned by Wall Street, the stock was trading at 24 cents and faced delisting by Nasdaq.

The company had missed fourth-quarter 2000 estimates by a mile -- and then it divulged accounting irregularities that forced a restatement of earnings for the prior two quarters (see BW, 8/6/2001, "Critical Errors at Critical Path"). It faced 52 shareholder lawsuits and an investigation by the Securities & Exchange Commission. With more than 1,000 employees and 77 offices around the world, Critical Path had total expenses in the first quarter of 2001 of $56 million, while its revenues were just $27 million. Plus, it carried $300 million in debt.

Yet, one year later, Critical Path is still here. Its debt has been restructured to a more manageable $38 million, the outfit holds $70 million in cash, and the cases with shareholders and the SEC have been settled. After slashing payrolls nearly in half and exiting noncore businesses, operating costs in the fourth quarter came down to $26 million.

Critical Path is still losing lots of money -- $2.9 million on an EBITDA (earnings before interest, taxes, depreciation, and amortization) basis on sales of $23 million in the fourth quarter, which were reported Feb. 5. The stock price is $2.35 -- still low, but now at a level that indicates investors have removed Critical Path from the critical list. "I would challenge you to find anyone who questions whether we're going to be around," says McGlashan, who became CEO in January, 2002, as part of a new management team. "We are clearly here to be a player."

McGlashan, 38, recently talked with BusinessWeek Online Associate Editor Amey Stone about how the company is changing its culture after scandal, and why it was able to avoid bankruptcy when so many former Internet stars crumbled. His next task: Win back Wall Street. McGlashan's strategy is to underpromise and overdeliver. Here's an edited transcript of their discussion:

Q: Let's start with what you did before you got to Critical Path. Were you brought in as a turnaround specialist?

A: People keep saying I'm a turnaround guy. I'm not really. I went to Yale as an undergrad and majored in history. Then I did a lot of different things, including working for McKinsey briefly, before I went to Stanford to business school and then joined Bain Capital. I started their West Coast office, and then I left to do a turnaround.

Q: So you are a turnaround specialist!

A: It was a small, little private company called Trade that had been funded in part by Bain, and I learned a lot about how little I knew. You go in as a VC thinking you understand what it takes to run a company -- and I realized I didn't have a clue! So I learned the hard way by making a lot of mistakes.

Then in 1994 I started a venture firm with two partners called Generation Ventures, and we did business in China. I got excited about one of the companies we started called Pharmanex, which I ended up becoming the CEO of. We built that company, which today is one of the largest U.S. supplement companies, until it was acquired.

In 1997, I left and joined Whitney & Co. as a venture partner out in San Francisco. I started an affiliate fund called Vectis Group. Our whole mission was to identify great technology companies which we could help by adding operational talent to them and helping them globalize, particularly in Asia, where I had a lot of experience. That's when I came across Critical Path. My first interest was really in the business opportunities it had in Asia.

Q: Do you see any similarities between what happened at Critical Path and what happened at Enron?

A: What happened here, although I wasn't here at the time, was not an earnings-management game the way Enron played it. [At Critical Path] you had a situation where Sales played games with individual contracts, and it was the company that uncovered it and went public with it.

But there are some fundamental cultural issues facing businesses today, highlighted in the Enron debacle that are consistent with what happened at Critical Path. Part of the problem is the tremendous pressure on executives to hit growth targets, typically top-line revenue targets. Here, executives had incentive plans that focused on top-line revenue growth -- and they did what they had to do to hit their top-line numbers. The stakes were very, very high.

That focus on growing revenues encourages people to ignore the basics of running a business. The basics that I was accustomed to -- financial controls, cash management, and earnings orientation -- just were not present in this company when I got here.

Another part of the same issue is the way the market reacts when companies miss earnings targets by a few cents. Companies built accounting systems in response to what the Street wants -- and the Street wants reliability, predictability, time and time again. But you can't run a business that way.

All this talk about managing by quarterly earnings is old stuff. Where it becomes pernicious, I think, is when the stakes get as high as they are now, where if you miss by a little bit, your stock drops 30%. I hear stories about how the previous management team at Critical Path was constantly monitoring their stock price. It just creates a very unhealthy environment.

What that has done, in my view, is create far too much short-term thinking and far too much pressure on human beings to play games.

Q: What can be done about it? Do you favor new regulation?

A: You can treat it systematically, with all sorts of rules and regulations -- but until you deal with the fundamental cultural issues, I don't think the problem is going to get solved.

Q: What are you doing to prevent more ethical lapses at Critical Path?

A: Corporate ethics is a cultural issue. The best way to change a culture is to change people. I don't mean helping people grow as individuals. I think unethical people remain unethical people, and sloppy people remain sloppy people. So what we've done is bring in new people who have the right kind of ethics.

We brought in classy people who have had extraordinary careers, who have reputations and wouldn't conceive of doing something that would jeopardize their reputation. We need people with real integrity who care about doing the right thing. And, by the way, [people] who want to build something important and are not just here for a quick fix or to make money tomorrow.

Q: What else have you done to change the culture?

A: On top of that, we've put in internal controls. For example, every sales contract has to go through both Finance and Legal. In fact, I can't imagine running a business where you didn't have Finance and Legal approving contracts. But this company had sales approving contracts, historically. That's a problem.

Creating transparency in the management team is also extremely helpful. Our executive team includes all the key functional areas, and I try to get them to interact with each other, to be critics of each other.

Q: How do you do that?

A: A big part of it is information dissemination. Every week we put together what we call our management dashboard. It's a report on results from all the key areas of the company. It's only two pages and is reviewed by everybody on the executive team.

What I say all the time is, all the departmental issues are your issues as much as they're my issues, guys. All of us share the same level of responsibility for the outcome. So if sales aren't coming in, it's not just sales fault. It's all our faults, so we all need to work together as a team.

We still have a long way to go in making the company do what it can do. We've got the technology, we've got the market opportunity. Now our challenges are all execution. During the turnaround, it was much more crisis management. We were worrying about whether we would survive as a company.

Q: Did you ever file Chapter 11?

A: No, we never did.

Q: It must have been debated. Why didn't you do it?

A: We were valued as if we were going to die. Everyone assumed we were dead, were going bankrupt. But doing a bankruptcy of any kind means you're basically wiping out a whole class of shareholders and saying, "You lose." From a fiduciary perspective, you have to think about the customers, the employee population, and all the various debt and equity stakeholders. In a bankruptcy, they all get wiped out.

My job is to create a wonderful environment to work in, to take care of our customers, and then on the shareholder side, to create value. That's what I'm getting paid to do. I can't imagine taking a company through a bankruptcy if you can avoid it -- most of the companies that had the same list of problems we did, didn't by the way.

Q: How did you avoid bankruptcy?

A: First, we convinced our customers that we were going to be around. We asked them to sign nondisclosure agreements, so they couldn't trade the stock, and then we explained that we were restructuring the debt and getting additional financing. Reducing our debt burden was really key. We didn't have a lot of wiggle room, but we had an extraordinary customer base that stuck with us. Basically, our technology was able to overcome the concern the customers had about our viability.

We were zipping all over the world talking to customers, while at the same time trying to put out a fire hear, a fire there. The analogy is driving a car while changing the tires. That was sort of the feeling.

The last piece, which was critical, is that we didn't lose one senior level engineer. The whole area of Internet communication is a very sexy space. The core of our business is providing the infrastructure that underpins any form of Internet communication: e-mail, voice-based, multimedia. During all the turnaround, we actually increased the budget of R&D. We realized we couldn't lose these people. And we've been able to build an incredible management team because the stuff we're doing is very exciting, and we can build a huge company if we execute properly.

Q: Now that the turnaround phase is over, will Critical Path remain an independent company?

A: My philosophy is that if we can create huge value as an independent company, great. If the only way for us to really realize the value for the employees, the customer, and shareholder is to ultimately be acquired down the line, fine also. But we have the best technology in our industry, and we've built an extraordinary team. We are clearly here to be a player.

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